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How Problematic is a Financial Restatement?

“On August 12, 2014, the Board of Directors and the Audit Committee of the Board of Directors of Ocwen Financial Corporation, after consultation with Deloitte & Touche LLP, the Company’s independent registered public accounting firm, determined that the Company’s financial statements for the fiscal year ended December 31, 2013 and the quarter ended March 31, 2014 can no longer be relied upon as being in compliance with generally accepted accounting principles.”  (8/12/2014, Securities and Exchange Commission, Ocwen Financial Form 8-k)

As the auditor for Ocwen, it is the responsibility of Deloitte to identify material misstatements.  As required by Auditing Standard No.12, “The objective of the auditor is to identify and appropriately assess the risks of material misstatement, thereby providing a basis for designing and implementing responses to the risks of material misstatement.”

At this point it is unclear whether the Ocwen material misstatement is due to an error in the application of accounting guidelines; or due to fraud.  The top accounting reasons for financial restatements include  - debt and securities issues; expense recording; reserves and accrual estimates; executive compensation; revenue recognition; and, inventory.  While the most probable fraud committed is the management of earnings to mislead investors.  But neither option is very positive for a company to admit.

Regardless of the accounting reason, a restatement shakes the confidence of investors, credit institutions and potentially customers/clients.  Regulatory scrutiny may increase and your ability to grow constrained.  As the actual impact to earnings is directly related to the issue, an average cost to restate cannot easily be projected.

In this situation, in response to the announcement – The Ocwen share price fell 4.5% the day of the announcement, to $25.16; Block & Leviton LLP announced that it was investigating the company and certain officers and directors to determine if anyone profited from the alleged accounting errors; The Rosen Law Firm announced the filing of a “Securities Class Action” against Ocwen Financial Corporation; The SEC subpoenaed records from Ocwen regarding its dealings with sister companies; and, S&P lowered its outlook on Ocwen Financial to negative.

Unfortunately, this situation with Ocwen is not uncommon.    According to research performed by the Center for Audit Quality, from 2003 through 2012, 10,479 entities required restatements, i.e. SEC 8-K filings.  For this 10 year period, restatement counts ranged from a high of 1,784 in 2006 to a low of 711 in 2009; averaging 1,048 per year.

So what can a company due to avoid this situation - Seek guidance from an Accounting professional on the proper application of GAAP, for your situation; remove the opportunity for fraud to be committed; maintain a strong Internal Control environment including a segregation of duty analysis; Implement conservative policies and procedures and reduce the manual intervention which causes errors; and, ensure an ethical environment, but maintain a Whistleblower program.

As the SEC continues with the implementation of the JOBS Act, one can only wonder about the frequency of material misstatements, requiring financial restatements with small and medium-sized non-public entities.

Comments

Topic Expert
Regis Quirin
Title: Director of Finance
Company: Gibney Anthony & Flaherty LLP
LinkedIn Profile
(Director of Finance, Gibney Anthony & Flaherty LLP) |

Update - "U.K. supermarket operator Tesco PLC issued its fourth profit warning in three years and said it is investigating why it overstated its most recent profit forecast by more than $400 million, the WSJ’s Lisa Fleisher and Peter Evans report."

Chris Shumate
Title: Accounting Manager
Company: Dominion Development Group, LLC
LinkedIn Profile
(Accounting Manager, Dominion Development Group, LLC) |

Financial restatements are problematic, indeed. According to an article published January 29, 2014 (http://www.complianceweek.com/blogs/accounting-auditing-update/investors-punish-material-restatements-study-says#.VCFcn_ldXt4) can cause a three year loss of investor confidence. Not only is investor confidence lost for nearly three years, the average stock price dropped 7.2% for companies with material misstatements.

The same article points out something that may be a little scary for the CEO, CFO, external auditors, the audit committee chair, or a combination of the aforementioned which could find themselves replaced to help regain investors' confidence.

A $400 million overstated profit forecast and its fourth profit warning to boot, there may be more than just CEO, CFO, etc., that needs to be replaced at Tesco PLC.

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